Some random thoughts on game theory, behavioural economics, and human behaviour

Sunday, 15 December 2013

Skiing holidays, the costly to fake principle and online shopping

Travel agents have recently reported a new money making scam. The basic idea is to set up a bogus website selling chalet holidays in ski resorts, or to more simply sell a chalet holiday that does not exist. This scam particularly caught my attention because we often book online chalet holidays! And the emotions reading about it aroused were primarily ones of fear and mistrust - this could happen to us and so maybe we should not buy holidays online anymore. The costly-to-fake principle is a nice way to try and make sense of all this.

In any economic transaction there is an element of uncertainty, because you cannot have perfect trust in the person you are trading with. When we book a ski holiday we have to put some faith in the travel agent to deliver what is being promised. Similarly the travel agent has to put faith that we will pay on time and not trash the chalet. Ideally we would like to reduce uncertainty as much as possible by trading with people we think we can trust. The extent that we will be able to do that depends on the costly to fake principle.

To keep things simple suppose there are two types of trader - honest travel agents and fraudsters. Clearly the skier wants to book a chalet with an honest travel agent. If honest travel agents and fraudsters are indistinguishable then she will probably be too scared to book a holiday. This provides an incentive for honest travel agents to try and signal they are honest. Ways they can do this include: a registered address, shiny website, good reviews, official accreditation etc. The problem is that the fraudsters also have an incentive to signal they are honest. And what's more that is there sole objective. The honest travel agent is busy running a travel agency, and so signalling honesty is likely to come down the list of priorities. The fraudster, by contrast, has nothing else to do other than make it look as though they are honest.

The only way we can escape this problem is if honest travel agents can find a signal of honesty that it would be costly for a fraudster to fake. This way we get a separating equilibrium where the honest travel agents are distinguishable from the fraudsters. An office in a ski resort is very costly to fake and so is a strong signal. A bright shiny website, however, is not at all costly to fake. Online shopping, therefore, has a basic credibility problem: we should be sceptical of online shops and if we are sceptical then we may refrain from buying things.

This problem is not confined to ski holidays but a general problem with online shopping. And the consequences are interesting to explore. The first point to make is that this credibility problem with online shopping does not mean we will not use online shops. Amazon is a pretty blatant example of that. Amazon, however, has satisfied the costly-to-fake principle with its size and reputation. Big firms can succeed on line. The problem is likely to be for small firms. The more fraudsters there are, the more reluctant we will be to buy from small online retailers, and the more we will rely on the giants like Amazon. So, basically, competition is likely to suffer the more we rely on online shopping.

This conclusion of diminished competition may seem out of place when we think to EBay or online marketplaces. Surely these have empowered competition? The thing to keep in mind is that the advantages of online shopping are precisely what makes it easy-to-fake. Online retailing has such low fixed costs - you do not need a shop or to search hard for customers - that anyone can do it. But, because anyone can do it, anyone can claim to be doing it! So, beware of the fraudster.